You can't legislate honesty

Posted: Jul 16, 2007 4:17 PM
You can't legislate honesty

The Congress of this great nation is trying to come up with a bill to help the mortgage industry manage itself and protect borrowers, brought on by the sub prime crisis. Great idea if it would work, but how do you get people to stop being people? Unfortunately, borrowers will not always tell the truth. I know that probably doesn't shock you, but the damage done by these false statements can be seen in today's real estate market. I didn't mean to cast dispersions on borrowers alone when the mortgage industry, especially mortgage loan officers are right up at the top of the list of those who more than bend the truth. There is enough blame to go around for everyone. And while we are spreading it let us not leave out the mortgage companies who not only bend the truth they simply tell lies: "We make enough on you during the term of the loan so we do not have to charge you any closing costs!"

Let us look at the three areas of the problem that could just be turned around if we could get everyone to stick to the truth. They are borrower's misstatements, loan officer's omissions and lenders need to deceive.

We will start with the borrowers. Years ago lenders put in stated income loans to help self employed people get loans. Self employed generally write off everything they can to reduce their taxable income and thus their tax bill. Looking at their tax returns would not tell any financial story and thus the lenders allowed them to state what they made, depending on their credit score. The lenders would check their income and make sure it fell within a range for their profession. As a mortgage advertisement states " people are smart" and thus they upgraded their profession or job. Gardeners became landscape contractors, handymen became finished carpenters, salesmen became sales managers, paralegals became attorneys, etc. The better the job title the higher they could state their income. The borrowers had plenty of help from the loan officers in their creative writing so you can't just blame the borrowers.

As long as stated income loans were performing well it was a better way to finance a house.

The borrower needed less documentation and the lender had less to analyze and everyone was happy. Sub prime borrowers got into the act and allowed stated loans for self employed people with lower credit scores. Even that seemed to work out well. Then came the sub prime lenders who gave employed borrowers the right to state their income which wasn't bad enough, they did it to 100% financing with low credit scores to fill a niche that was "ripe". It was also very dangerous and they eventually paid the ultimate price and went out of business.

I am sure they will tell you now that it was a mistake but it wasn't their fault alone. The lying of the borrowers made sure it wouldn't be a feasible idea. Writers note: Just because you are allowed to state your income doesn't mean that you can misstate it to help you qualify. Take the lying away and maybe the companies would still be in business.

Now let's look at the loan officers and their part in "the lying environment". Three areas they have problems with are negative amortization, interest rates on adjustable loans and prepayment penalties. There isn't any excuse for a loan officer to fail to tell a borrower who is interested in an option arm that he or she will have negative amortization at some time in the loan. The most that the majority of loan officers will say is that a potential for negative amortization exists. Okay that is a way of stating the obvious but put a percent of the potential as 100%. The majority of homeowners in danger of losing their homes come from the fact that their balance is increasing, their rates are high because they can no longer pay the teaser rate (too much negative and the lender takes the option away to pay the teaser rate which is less than the interest on the loan) and prices are going down. There is no excuse for a loan officer who refuses to inform the borrower of the possibility mentioned above.

Many loan officers fail to inform borrowers how their adjustable rate works, but unfortunately it comes from lack of knowledge more than fear of losing a loan. An adjustable rate is made up of a margin (profit margin) and an index. The index is a financial one such as the prime rate, the monthly t-bill average, libor, etc. The margin is what is added to the index to determine the rate at the change date (every month, each six months or every year). There can be limits to the increase at the change date or their can just be a lifetime limit (cap).

Prepayment penalties come in several varieties and can be okay or devastating. The normal prepayment penalty is there to allow a lower rate and guarantee the lender that the return will be there for a period of time. There are soft prepayment penalties (waived on sale of the property) and hard ones that do not allow waiving under any circumstance. Some lenders will waive the prepay if you refinance with them or if it is a sale the new buyer will take out a loan with them. When they do that you are hit with a new prepayment penalty.

If the loan officers were knowledgeable and more concerned with the borrower then getting a loan they would explain all of these potential land mines to the borrower and we would have a better environment to finance your real estate.

Lenders have a perceived need to deceive, although I do not have the slightest idea why. Our industry is huge, there is plenty of business for everyone and we would have far fewer problems if the honesty started with them. Why advertise a low rate and an APR instead of stating how many points you will have to pay for the loan? Why advertise a "no cost loan" when it means a higher interest rate for the vast majority of borrowers which is a greater cost than the closing costs. Why emphasis the gimmick of the Option Arm, 1% interest rate, without telling the borrower that it is actually the payment rate, not the interest rate, and the interest rate is 5% to 8% higher?

Stop the nonsense and you stop the need for Congress to get involved. You can legislate forever and never accomplish anything until you can get mankind to adopt the "Golden Rule" and use it in their every day lives and not just with their friends and family.